Cash Balance Plans

Many professionals—doctors, dentists, lawyers—and small business owners often find they have spent so much time and effort developing their thriving practices and growing their profitable businesses that they just didn’t have the time to plan for their own personal retirement situation.

Many small business owners and professionals, however, have consistently been contributing to qualified retirement programs like 401k, profit sharing, Simple IRA or SEP plans. But market conditions haven’t gotten them to where they had hoped to be. The tech bubble of 2000 and 2001 and the financial crash of 2008 were setbacks that most accounts have barely recovered from. They now find that they’ve had to push their retirement back to a date much later than they had hoped for. OR…

Many professionals and small business owners hope their businesses and practices will be their retirement.

They hope they will be able to grow their practice and develop their business until they can sell the business and live off the proceeds in retirement.

They unfortunately find out and, in most instances they find out too late, that their practice isn’t worth what they envisioned it would be.

Or they find out as part of the terms of sale of the business (because in many respects they are the business) they have to stay on in an active capacity for a protracted period of time.

In either of these scenarios, that’s usually not the type of retirement they had thought all their hard work would reward them with.

401ks, profit sharing plans, simple IRAs, and SEPs are all valuable retirement planning tools for small business owners and professionals.

However, as we’ve seen, they’re not risk-free . . . they don’t guarantee outcomes . . . and oftentimes, by themselves, they just won’t get the job done.

A different type of qualified plan can help out. It’s not meant to replace the 401k/profit sharing plan/Simple IRA/SEP. It’s called a cash balance plan and works best when it is used in conjunction with 401k/profit sharing/simple IRA/SEP.

Doctors, lawyers, dentists, accountants and other small business owners and professionals should be asking themselves if they are maximizing their ability to BUILD THEIR RETIREMENT SAVINGS AND LOWER THEIR CURRENT TAXES.

Professionals and small business owners typically start generating revenue later in life and thanks to Congress, there are ways to make up for that.

Helping people save for retirement through tax-advantaged plans is sound public policy.

One such plan . . . the cash balance plan . . . has been growing in popularity. Traditional pension plans have been declining while cash balance plans have been increasing.

That growth driver is a small business owner. Doctors and dentists account for 38% of all cash balance plans.

Cash balance plans work best when they supplement existing 401k/profit sharing / Simple IRA/SEP. In fact, 96% of all cash balance plans exist with another qualified plan—a plan like a 401k/profit sharing plan/simple IRA/SEP.

Cash balance plans allow professionals and small business owners to compress 20 years of retirement savings into 10 years and generate additional tax savings that are substantial.

Let’s take a look at a hypothetical example.

Dr. Jones has a well-established pediatric practice with two employees.

As is the case with other doctors, he spent most of his energy building his practice in the early years, putting off saving for retirement until later.

He paid off medical school loans, got married, bought a house and educated his children. He started a 401k plan at work, but now he’s concerned the plan will not be enough for him to retire on in 10 years when he’s 65.

He is putting aside the maximum permitted—$24,000 in 2015—but that’s really not enough to make a difference for him. .

With a cash balance plan, Dr. Jones can set aside about $200,000 a year and he can deduct that entire amount from his taxable income. Over 10 years, he’ll have contributed enough to reach about $2.5 million, which is the IRS’s maximum benefit limit.

Then he can close the plan and roll the proceeds into an IRA.

From there he/she can work with a fiduciary advisor to develop their distribution strategy.

The older you are, the higher the possible cash balance plan contributions . . . which means you can accelerate your retirement savings and substantially reduce your current tax liability.

For example, if you were born in 1950, your maximum contribution and accordingly, your maximum tax deduction, could be as much as $260,000 ($237,000 cash balance plus $24,000 401k). If you were born in 1960, you’d be looking at about $199,000 in contributions and current tax deductions, and if you were born in 1970, you would be able to put away tax deferred about $120,000.

Cash balance plans allow small business owners and professionals to compress 20 years of retirement savings into 10 years and realize substantial additional, above the line, tax savings at the same time.

Many small business owners and professionals have delayed saving for retirement for a variety of reasons. The cash balance plan or other hybrid defined benefit plans might be the solution. Depending on the demographics of your firm you could retain more tham 90% of the contributions to the plan. It is a win for your employees because you will contribute more for their retirement. You win because you can pack 20 years of saving into 10 years or less. Increasing your tax deductions while offering a benefit which will help attract and retain top talent.
English: The Frances Perkins Building located at 200 Constitution Avenue, N.W., in the Capitol Hill neighborhood of Washington, D.C. Built in 1975, the modernist office building serves as headquarters of the United States Department of Labor. (Photo credit: Wikipedia)

For a small but growing number of companies, cash balance plans offer a third alternative. Cash balance plans have existed for many years. However, until relatively recently, regulatory and legal uncertainty kept many companies from adopting these plans. Since cash balance plans have gotten the final stamp of approval from the IRS and the U.S. Department of Labor, their numbers have been increasing.Compared to the hundreds of thousands of 401(k) plans in existence, cash balance plans remain a relative drop in the bucket. According to the 2012 National Cash Balance Research Report published by Kravitz Inc., the number of cash balance plans increased 21% last year. The most recent IRS data from 2010 shows 7,064 active cash balance plans. Just ten years ago in 2001, that number was 1,337. However, the report found that growth of cash balance plans continues to outpace the growth in any other type of retirement plan.

Left unchecked the retirement crisis in America will only worsen. Steps must be taken to control the banks and the other Wall Street bullies. Investors deserve and require a top notch retirement plan no matter what size company they work for. Business owners and managers need to address this or the federal government will be forced to.
retirement (Photo credit: 401(K) 2012)

Savings rates remain very low

The median contribution level for workers in 401(k) or similar plans is 7 percent. This is up from 6 percent in 2011, but still too low a savings rate to fund a comfortable retirement. Think about it: Retirement is likely to last roughly half as many years as a career. How can you expect to replace most or all of your income if you are only setting money aside 7 percent of that income each year? With diminished expectations for the stock market, and bond yields and savings account interest rates approaching zero, most people are not going to be able to grow their way to adequate funding. Saving more is the only way to make it work.

2. Retirement targets are also too low

The reason savings rates are so low is probably that people are underestimating how much they will need in retirement. According to the Transamerica study, the median savings goal of American workers is $500,000 — but how many younger workers understand that inflation is likely to cut the value of that amount by at least half by the time they retire?

3. Too many people are relying on guesswork

It’s no surprise that savings rates and retirement targets seem off-base, because people simply guess at them. The Transamerica Center found that nearly half (47 percent) of respondents chose a retirement target by guessing.

4. Funding levels are off target

While the median retirement target is $500,000, the survey found that 39 percent of workers in their 60s had saved less than $250,000. That leaves them with too much ground to make up in too few years.

5. People seem to be betting on good health

The survey found that most Americans plan to retire after age 65, or not at all. Also, most plan to work after retirement. Working longer may be an inevitability for many people, but it is hardly an ideal retirement planning solution. After all, it means staying healthy enough to work productively, and that is no sure thing for people over 65.

6. Many start planning too late

It’s only natural that older workers are more focused on retirement planning than younger ones, but that is also unfortunate. The younger you are, the more powerfully you can impact your retirement savings, because you have that many more years to contribute money and benefit from investment returns. The survey found that people in their 60s are more likely to have a retirement plan and work with a financial planner than people in their 20s. The problem is that by the time you are in your 60s, your options for significantly improving your retirement funding are very limited.

Procrastination is the American way. Many ask the question why save now for something that is 30 or 40 years away. The answer is the sooner you start the less painful it is and the less RISK you need to take to reach your goals. Remember planners usually win.

The Pension Protection Act of 2006 has made is possible for many small business owners to pack 20 years of savings into 10. The regulation changing made make the defined benefit hybrid plans legal and very attractive. Although not for every business or professional firm when these plans work it is a win win for the employer and their employees.
President George W. Bush signs into law H.R. 4, the Pension Protection Act of 2006, Thursday, Aug. 17, 2006. Joining him onstage in the Eisenhower Executive Office Building are, from left: Secretary of Labor Elaine Chao; Rep. Buck McKeon of California; Rep. John Boehner of Ohio; Senator Blanche Lincoln, D-Ark.; Senator Michael Enzi, R-Wyo., and Rep. Bill Thomas of California. (Photo credit: Wikipedia)

Imagine this scenario: Greg is a 55-year-old client who has owned a highly successful marketing firm for 20 years. He has three employees in their 20s and early 30s who make between $20,000 and $35,000 a year, while Greg takes home $200,000 a year. Greg is looking for a retirement plan that will allow the maximum contribution and provide the biggest tax deduction and savings. Greg has not saved as much for retirement as he would like because his focus has been getting his children through college. He is now ready to contribute as much as possible to a retirement plan, as he wants to retire in the next five to 10 years.How would you advise this client?

While small business owners typically use defined-contribution plans with an elective deferral feature to provide retirement benefits to employees, defined-benefit plans may be ideal for small-business owners over 50 who are interested in saving a substantial amount of money for retirement in a short time period.

Defined-benefit plans promise a specific annual retirement benefit based on the percentage of current income the business owner wants to have at retirement, or the percentage of current income he or she can comfortably afford to contribute, up to an annual maximum of $200,000. These plans are best suited for small business owners who are at least 40, earn $100,000 or more a year, plan to contribute more than $50,000 annually to their retirement and have five or fewer employees.

Sponsoring a defined-benefit plan for employees provides them with a determined monthly benefit upon retirement. Defined-benefit plans can be structured to reward employees who stay with the company while minimizing retirement benefits to those employees with short tenures. Participants are not taxed on the retirement benefit until they actually receive a distribution from the defined-benefit plan. An added benefit to the small business owner is that employer contributions provided to a defined-benefit plan are fully deductible as an ordinary business expense.

When considering sponsoring a defined-benefit plan, small business owners must also consider the costs and expenses associated with operating a defined-benefit plan. Such expenses include:

Funding the defined-benefit plan

Retaining an actuary to determine the amount of the employer contributions

Insurance premiums for the defined-benefit plan if the business has more than 26 employees

However, the advantages of defined-benefit plans often outweigh these expenses for small business owners in their late 40s, early 50s or older who meet the following criteria:

They want to maximize their annual retirement contribution and are seeking the maximum tax deduction

The company has stable cash flow

The company has no employees, few employees or a number of employees who are significantly younger than the owner

Small business and professional service firms have more options when saving for retirement than they are aware of. The Pension Protection Act of 2006 makes the hybrid defined benefit plan a great alternative for many business owners.

Please comment or call to discuss how this affect you and you company.

When the demographics of a business are right the defined benefit hybrid plan is a great option for many small business owners as well as professional service firms. Assets in a qualified retirement plan provide asset protection from creditors and an accelerated saving rate, up to $250,000 deduction. Many small business owners and professionals are guilty of not saving enough for retirement. This option gives them the opportunity to catch up.
English: Retirement savings for various periods with squirrel and nut analogy (Photo credit: Wikipedia)

Would an extra $2.5 million come in handy at retirement? Would you like to defer taxes on over $200,000 of current income each year? Would you like to see a higher proportion of your retirement plan expense go to yourself, or your key people if you own a business?Whether you are a realtor, consultant, physician, attorney, independent contractor, sole proprietor, owner or a partner in a small or large business, you can turbo-charge your retirement with a cash balance plan on top of your existing 401(k) plan. You can be a one person shop, or highly paid executive or professional in a large firm.

Many employers are looking for benefits to attract and retain talented employees, while increasing their own deductible contributions. The hybrid defined benefit/defined contribution plan may be the answer. Changes to retirement plans in the Pension Protection Act of 2006 make this option very attractive for many small business owners and professional firms.

“Employers that provide DC-only retirement plans recognize they need to increase employee engagement with their plans in order to improve their employees’ retirement readiness. Effective DC retirement plans require that workers understand and take full advantage of them, which is why organizations are moving beyond merely making these benefits available,” says Mike Archer, senior retirement consultant at Towers Watson.Other key findings from the survey include:

• Hybrid plans, primarily cash balance plans that combine features of 401(k) plans and traditional pension plans, are now the most prevalent type of DB plan for new hires. More than half (54%) of DB plans are hybrid plans, while 46% are traditional plans.

• Over three-fourths (78%) of DB plan sponsors for new hires believe employees value the guaranteed benefits from pensions more than other features, compared with only 50% of DC-only sponsors.

• Additionally, 54% of DB sponsors for new hires believe employees value income throughout retirement, while only 28% of DC-only sponsors do. Other Towers Watson research shows a growing number of employees are willing to pay more from each paycheck to ensure a guaranteed retirement benefit.

There are plan designs available for successful small business owners and professional service firms to add a hybrid defined benefit plan and attract and retain talented employees. These plan designs have become a viable solution by provisions in the Pension Protection Act of 2006. This plan design does not work for all companies however when it does work it is very attractive.
President George W. Bush signs into law H.R. 4, the Pension Protection Act of 2006, Thursday, Aug. 17, 2006. Joining him onstage in the Eisenhower Executive Office Building are, from left: Secretary of Labor Elaine Chao; Rep. Buck McKeon of California; Rep. John Boehner of Ohio; Senator Blanche Lincoln, D-Ark.; Senator Michael Enzi, R-Wyo., and Rep. Bill Thomas of California. (Photo credit: Wikipedia)

The survey found that the number of DB plan participants hired within the last two years who said the retirement program was an important factor in deciding to join their employer jumped from 27% in 2009 to 70% in 2011. At employers with DB plans, employees hired within the past two to five years were more than 3.5 times as likely to say their retirement program strongly affected their employer choice decision (67% versus 18%). Meanwhile, retirement programs have become only slightly better attraction tools at companies with only a DC plan. Of this group, 19% of employees hired over the same time span reported that the retirement program was an important reason for their employer choice.Many more workers who accept a job that offers a DB plan intend on a long career with their employer. More than three-fourths (77%) of new hires at companies with a DB plan say the retirement plan gives them an important reason to stay on the job, and 85% hope to work for their employer until retirement.

For companies to remain competitive for younger, talented employees they must listen to what these prospective employees are looking for. There are plan designs available to accommodate a defined benefit plan for smaller employers.

Please comment or call to discuss what options are available for your company.

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Is the Recession Causing Small Retirement Plans to Skimp on Compliance Efforts? (401kplanadvisors.com)

Majority of Plan Participants Lost on Retirement Planning, Seek Direction From Employers (401kplanadvisors.com)

The cash balance plan design can allow small business owners and professional service firms to take significant tax deductions to a qualified retirement plan. Provisions in the Pension Protection Act of 2006 clearly allow the cash balance plan to work for many successful business owners and professionals. Statistics show many successful baby boomers have not set enough aside for retirement and this plan design allows them to catch up while providing an employee benefit which will attract and retain top talent.

Cash balance defined benefit plans are offered by many large employers; according to a recent survey by Towers Watson, 25 percent of the Fortune 100 offer these retirement plans to their employees. A cash balance plan is a hybrid retirement plan that shares some features of both a traditional pension plan and a 401(k) plan.
Here’s how they work:- Like a 401(k) plan, your benefit is an account that grows with contribution and interest credits. Usually you can take the full amount in your account with you when you terminate or retire.

– Like a pension plan, your employer takes any investment risk; before you retire, your account always earns the interest crediting rate that’s specified in the plan, even if the assets in the pension trust tank due to a market downturn.

– As with a pension plan, at retirement, you have the option to have the plan pay you a monthly retirement income — a.k.a. an annuity — for the rest of your life, or take the money and roll it over to another type of income-generating account.

So when you retire, should you take your account and roll it over to another type of account that could generate a monthly income for you, such as an IRA or annuity, or should you elect to have the plan pay you the monthly annuity? One way to come up with the best answer to this question is to compare the monthly income you would get from your employer’s cash balance plan to the annuity income you’d get if you took the lump sum payout and bought an annuity from an insurance company.

The cash balance plan is an excellent plan design for many closely held businesses and professional service firms. This is not appropriate for all companies but when it works it is a very attractive benefit to attract and retain top talent.

Please comment or call to discuss how this plan design might work for your company.

Retirement plan design is vital to the success of very plan. The cash balance plan should be considered by professional service firms, closely held small businesses, and any firm with solid cash flowlooking for additional tax deductions. This plan design will help attract and retain top talent.

Sigmund says that a cash balance pension plan is an especially popular tool for professional practices.

“If they have not maxed out their 401(k) plan, we recommend that they do so prior to establishing the cash balance pension plan. In combination, these two plans can enable the organization to cost effectively meet a variety of goals relative to the principles of the practice.”

These hybrid retirement plans offer the business owner the opportunity to deduct income beyond the defined contribution limits. At the same time you will attract and retain talented employees.

Many successful companies (especially professional firms like medical groups and law firms) are considering whether to increase retirement plandeductions for 2011. This post highlights the action steps to take while there’s still time.Note: We’ll be focusing on cross-tested profit sharing plans and cash balance plans. These plans allow owners to make large tax-deferredretirement contributions in exchange for providing a generous employee retirement allocation (usually 5% of pay if there’s only a profit sharing plan, or 7.5% of pay if there’s a cash balance plan too).